The first wave of banking-as-a-service (BaaS) has proven the business case that onboarding customers (and their deposits) can be performed very efficiently outside of traditional banking applications.
However, the first wave of BaaS is displaying its limitations through a recent regulation clampdown from governing bodies, including the Office of the Comptroller of Currency, and friction among banks, BaaS providers and fintech. A possible solution may be available through embedded banking, with the banks owning their tech stack.
With venture capital money flooding the fintech market, the power differential in these evolving relationships has begun to skew toward fintech and BaaS providers, though the partnerships still work for banks as they can acquire lots of new deposits quickly via their fintech partners. A report from Oliver Wyman supports this, as typical financial service providers spend between $100-$200 on customer acquisitions, whereas with the BaaS model, this expenditure drops to $5-$35.
While these numbers look very appealing, the main trade-off is that banks surrender last-mile delivery of their financial products to end customers. This customer distance means banks struggle to use analytic tools to track consumer spending and provide personalized product recommendations and insights, along with blurred lines regarding who is responsible for Know Your Customer (KYC) and other compliance requirements.
In 2022, the Consumer Financial Protection Bureau (CFPB) invoked its dormant authority to regulate fintech to level the playing field between banks and nonbanks. While the Federal Trade Commission has always been able to regulate fintech under the unfair, deceptive or abusive acts or actions regulation (UDAAP), recently, fintech has come under further scrutiny.
Banks are also wondering if there is an alternative to the middleman. They no longer want to be relegated down the value stack where they hold the deposits and regulatory requirements without the customer relationship or economic benefits when the program succeeds. So, what’s the answer?
A big push from regulators has accelerated the formation of the second wave of BaaS: embedded banking. By removing the BaaS provider middlemen, brands and fintech can go directly to the banks. This allows the bank to own the compliance and regulatory monitoring to meet agency oversight standards. Financial institutions can then manage their own accounts, grow their fee and revenue streams, and leverage deposits for lending use cases.
Giving banks the option to own their own tech stack in the cloud means they retain full transparency into their customers, accounts and transactions. Furthermore, by having access to the tech stack, the banks are given the choice of the providers and processors they want to include in their ecosystem. In doing so, they now have a platform to embed finance into their applications as well as embed banking into non-financial applications with confidence.
With banks in overall control of their fintech programs, bypassing the middleman provides them with a better economic model that balances more in their favor. This can allow them to offer new products for customers and build revenue streams that propel their core business forward and cover their own compliance burdens.
Most importantly, the banks can align with regulatory requirements and reporting, gain approval for fintech programs, and avoid the risks of the bad press found in wave one.
BaaS has reached a fork in the road, and financial institutions get to choose which route to follow. While both roads are viable, one shows more benefits and greater control for banks.
The second wave of embedded banking allows banks to win. By controlling the tech stack, the banks can bring products to market directly with brands and fintech without the need for their own development. Furthermore, financial institutions have complete oversight of regulatory and compliance requirements, choice in their providers, and economic models that drive greater revenue for their core business. It is time for banks to explore the options from a leadership seat.
Riaz Syed is founder and CEO of Infinant